Indifference Curve Analysis: Rambabu Sambattina
Indifference Curve Analysis: Rambabu Sambattina
Curve
Analysis
Rambabu Sambattina
Ordinal Utility Approach
Rambabu Sambattina
Ordinal theory is also known as neo-classical theory of
consumer equilibrium, Hicksian theory of consumer
behavior, indifference curve theory, optimal choice
theory. This approach also explains the consumer's
equilibrium who is confronted with the multiple
objectives and scarcity of money income.
Rambabu Sambattina
Indifference Curve
Rambabu Sambattina
Indifference Curve schedule
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Indifference Curve
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Indifference Map
refers to a set of
Indifference Curve.
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Assumptions of
Indifference Curve Analysis:
a) Consumer is rational.
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d) Consumer’s behavior is Consistent.
E.g. if consumer prefers A combination > B combination
at one time, then at another time he will not prefer
more of B combination than A combination.
e) Transitivity.
E.g. if consumer prefers A combination to B
combination and B combination to C combination, then
he will definitely prefer A combination to C
combination.
Rambabu Sambattina
Rambabu Sambattina
1) Straight line
indifference curve :
In case of Perfect
Substitutes, IC may be a
straight line with negative
slope.
e.g. Taj Mahal (X-
commodity) and Brooke
Bond tea (Y-commodity)
are perfect substitute of
each other.
Here,
MRSxy = 1
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2)Right-angled Indifference
Curve :
In case of Perfectly
Complementary goods, the
shape of IC is right-Angle.
e.g. a consumer will buy right
and left shoes in a fixed
ratio.
Here,
MRSxy = 0
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Rambabu Sambattina
The Budget line shows all different combinations of
the two commodities that a consumer can purchase
given his money income and price of two commodities.
Here;
Px= price of apples
Py = price of oranges
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Suppose ; a consumer has:
the different combinations that a consumer can get of these goods are :
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From Figure;
Budget line = AB
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1) Due to change in
Income:
Assumptions :
o price of two goods
remain constant and
o income of consumer
changes.
Change in Effect on
Income Price Line
Rise Shift to Right
Fall Shift to Left
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2) Due to change in the
Price of one
commodity:
Assumptions:
Income of consumer
remain unchanged.
Price of one commodity is
constant.
Price of other commodity
changes.
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Rambabu Sambattina
Consumer’s equilibrium refers to a situation in
which a consumer with given income and given
prices purchases such a combination of goods and
services which gives him maximum satisfaction
and he is not willing to make any change in it.
It is struck when
“what he is willing to buy coincides with what
he can buy”
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Prices of goods are constant.
Consumer’s income is also constant.
Consumer knows the prices of all things.
Consumer can spend his income in small quantities.
Consumer is rational.
Consumer is fully aware of Indifference map.
Perfect competition in the market.
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1) Price line should be tangent to Indifference Curve.
or
Slope of IC = Slope of Price line
or
MRSxy = Px/Py
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When the consumer is in
equilibrium, his highest
attainable Indifference
Curve is tangent to price
line.
From Figure:
At point ‘D’, slope of
Indifference Curve and Price
Line coincide. Therefore, first
condition of consumer’s
equilibrium is satisfied.
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It means that MRS of
Apples for Oranges should
be diminishing.
If at the point of
equilibrium, Indifference
Curve is Concave and not
Convex to the Origin, then
it will not be a position of
permanent equilibrium.
IT IS ESTIMATED AS
MRSXY = ΔY/ΔX
ON ANY POINT ON IC.
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According to this Law, “ as a consumer gets
more and more units of X , he will be willing
to give up less and less units of Y”
A 1 10 _
B 2 7 3/1
C 3 5 2/1
D 4 4 1/1
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Table 2. indicates that the consumer will give up
3 oranges for getting the second apple,
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?
It diminishes ;
As Law of Diminishing marginal rate of substitution is an extensive
form of Law of diminishing marginal utility.
According to Law of Diminishing Marginal Utility,
As Consumption by Marginal Utility goes on
Consumer
1) Increases 1) Diminishing
2) Decreases 2) Increasing
Consequently, consumer is willing to give up less and less units of
oranges for every additional unit of apple.
Therefore, Marginal rate of substitution of apples for oranges
diminishes.
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T he m a rg i na l ra t e o f s u bs t itu tio n is co ns ta nt
i f t o o bta i n o ne m o re u n it o f X, o n ly o ne
u nit o f Y is s a cr i fi ced to m a i n ta i n s a m e lev e l
of s a tis f a ctio n . M a rg i na l ra te of
s ubs t it utio n of p erfe c t s u bs tit utio n is
co ns ta nt . T A B L E 3 .
A 1 10 _
B 2 9 1/1
C 3 8 1/1
D 4 7 1/1
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Indifference
Curve will be a
Straight line
falling downwards
from left to right.
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It implies that as the stock of a commodity increases with
the consumer he substitutes it for the other commodity at
an increasing rate to maintain the same level of
satisfaction.
Table 4.
B 2 9 1/1
C 3 7 2/1
D 4 4 3/1
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Indifference
Curve will be
Concave to the
point of origin.
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Type of Price effect Income Shape of
goods effect Demand
Curve
1) Normal Negative Positive Slopes
Goods Upward
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Law of Diminishing
Basis of Law of Diminishing
Marginal Rate of
Difference Marginal Utility
Substitution
Unrealistic assumption
1) Measurement in Realistic assumption that
that marginal utility can
Cardinal/Ordina utility can be measured in
be measured in Cardinal
l numbers Ordinal numbers.
numbers.
Utility of one commodity Utility of one commodity
2) Independence is independent of the is dependent of the utility
of Commodities utility of other of other commodity.
commodity.
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Rambabu Sambattina